How To Use The Moving Average To Analyze Stocks

The moving average is one of the simplest tools in technical analysis. It is also one of the best trend following indicators that you can use. The moving average is the average price of the stock over a period of time. For example, a 50 day moving average will be the average price of the stock for the last 50 days. They are updated daily so when you plot it on the chart, it will form a line that smooths the price data.

There are many types of moving average. They include the simple moving average, the exponential moving average and the weighted moving average. I like to use the simple moving average and it is a staple on my charts.

The 3 moving averages that I use are:

  • The 20 day moving average
  • The 50 day moving average
  • The 200 day moving average

The chart above shows the S&P 500 Index with its 20, 50 and 200 MA. To a beginner, the moving averages mean nothing. But to a trained professional, this stock chart tells a lot of things about the health of the stock market:

  1. The market is in a very healthy short term uptrend
  2. The market is in a very healthy mid term uptrend
  3. The market is in a long term uptrend
  4. The market is in a very strong bull uptrend
  5. This is the time to buy breakouts
  6. This is the time to focus on buying the dips
  7. An investor can afford to hold a stock longer

The 20 Day Moving Average

The 20 MA is the shorter period among the 3 moving averages. I use it to determine the short term strength of a stock.

  • A stock that is above its rising 20 MA is considered to be in a short term uptrend
  • If a stock drops below its 20 MA, it is considered to be in a short term correction
  • If you like to trade bullish momentum stocks, make sure you choose stocks that are above its rising 20 MA

In the chart above, you can see how the 20 MA pointed out the short term uptrends and correction periods for Apple's stock.

The 50 Day Moving Average

The 50 MA shows the strength and health of a stock in the medium term. This MA is watched by almost all investors and traders. That's why it is called a major moving average.

  • A stock  that is above its rising 50 MA is considered to be in a mid term uptrend
  • A stock that is below its 50 MA is considered to be unhealthy and therefore not a good candidate for bullish momentum moves
  • A stock that drops below its 50 MA and does not move back up quickly is unfit to be held on

The 200 Day Moving Average

The 200 MA is perhaps the most important moving average. Besides the 50 MA, the 200 MA is watched by almost all investors and traders. It has such a big following and therefore it is also known as a major moving average.

The 200 MA is the final line between what is a good stock and what is rubbish. Most investors won't even touch a stock that is below its 200 MA.

  • A stock that is above its rising 200 MA is considered to be in a long term uptrend
  • A stock that is below its 200 MA is considered very bad and you should not even buy the stock

Only Buy Stocks That Are Above Their Rising 50 And 200 MA

An investor should always look at a stock's 50 MA and 200 MA. Only buy stocks that are above their rising 50 and 200 MA. Never buy a stock that is below its 50 and 200 MA.

Avoid Stocks That Are Below Its Declining 50 and 200 MA

If you see a stock that is below its declining 50 and 200 MA, stay far away from it. Trying to bottom fish and buy this stock is like trying to catch a falling knife.

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